Three growth areas I’ve been buying, and the next trillion-dollar company

LF Blue Whale Growth fund manager Stephen Yiu discusses three new growth areas he’s been buying, other portfolio activity, three bear market scenarios for 2023, and gives his views on comparisons to Terry Smith. Yiu also names the share that’s fallen hard in 2022 that he thinks could be the next trillion-dollar company.

Kyle Caldwell, collectives editor at interactive investor: Hello and welcome to our latest Insider Interview. Today in the studio, I have with me Stephen Yiu, manager of the Blue Whale Growth Fund. Stephen, thank you for joining me today. As we near the start of 2023, there's no shortage of headwinds and there's a potential global recession on the cards. What reasons for optimism are there for investors in 2023?

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Stephen Yiu, manager of the Blue Whale Growth Fund: I think that there's many different scenarios that we can work on. And I would probably want to start with the bearish scenario. So, we are in a bear market now, as we would all agree. But the way the bear market works is there’s still a few different ways of how the bear market operates. So, I lay out three scenarios, the first scenario being the market is going to go down dramatically from here in the next couple of months, in a very speedy manner. I think that's a good scenario because if you can survive that in the next few months, if the company that you invested in are quite high quality, they have net cash on the balance sheet and they are market leader, they can survive that.

Then we probably would have a long period of a bull market after that happened, which has brought out what we have experienced during the global financial crisis that the market was down by 50% after Lehman went bust. But then we had a good 10 years of good return for investors.

And then the second scenario is equally positive, that the market just doesn’t recover from here. It stays down, which is about probably 20% to 25% down this year, depending on which market you look at. But then next year, the return will be flat and then the next year the return would be flat again. So, the market doesn't recover. But if you can generate some alpha outperformance, which is what we're trying to achieve, then you might still be able to get some positive return on the back of that. So, the market just doesn't recover yet, [and] stays down there.

The last scenario of a bear market is the most bearish, and it is that the market just continues to go down a little bit every year. So next year, down about 5%, the year after down another 5%. And if the market just continues to go down a little bit every year, then no one's going to put any money in. So, I think that is the worst-case scenario. But I think the likelihood of the last scenario is quite low given what the central bankers are trying to do. They're trying to step up the rate of rising interest rates in a very short space of time. So that's why the market has been quite volatile and down quite a lot.

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Then if you look at the positives on the back of this, if you follow the recent inflation data in Europe, in the US, [it] has come down a little bit. If you look at many of the commodities’ prices, a lot of those are now below the level when we had the Ukraine crisis this year. Even the oil price is now flat on a year-on-year basis and a lot of commodities are a lot lower compared to before.

At the same time, I think we started to see some cracks in the housing market. OK, it's not positive for people who have a mortgage, but at the same time, it just slows down the creation of new wealth in the market, which is a headwind for inflation. So, we will have less inflation on the back of this. And, finally, I think next year, in the next six months or so, we should expect the interest rate cycle to have peaked. So, now in the US, it's probably about 5%, and I think in the UK it might be 3% to 4%. And once the level of interest rate has settled down and levelled, then I think if your company can continue to deliver the growth drivers they have in the pipeline, if they don't need to refinance the balance sheet with a high level of interest rate, which means if they are net cash, then they would do quite well.

So, we are quite optimistic about 2023 and onwards. Of course, in the shorter term, the market could continue to be volatile. So, now, you need to be cautious. But at the same time, I think there's some green shoots.

Kyle Caldwell: And given the point you just made about the short term, the market might continue to be volatile. Is that being reflected by the fact the fund has around 7% in cash? You're keeping some powder dry in case that happens?

Stephen Yiu: We have been reducing our cash since we published our factsheet a few weeks ago, and now we're just running short of 5% cash, and we are actually looking for new ideas. And we have invested in some new names, we have been buying some other stuff that wasn't in the fund before. And we are seeing opportunities in the market. So, the cash is always a byproduct of how much, in terms of opportunity set, that we see in the market. And at some point this year we had a high level of cash just because we didn't feel the opportunities or valuation was there. But now, I think a lot of things are now probably coming together. So, we are spending cash now.

Kyle Caldwell: So, what companies have you been buying or what sectors have you been moving into that you previously didn't have much exposure to? I saw that you made the point that you think in the next five years there will be a different set of growth winners compared to the previous five?

Stephen Yiu: Yes, so, if I look back over the last five years, we started with a blank piece of paper five years ago in 2017, and at the time we did not have as many technology companies that we ended up with during the pandemic period. Of course, I mean, we did have Adobe Inc (NASDAQ:ADBE), Microsoft Corp (NASDAQ:MSFT), Amazon.com Inc (NASDAQ:AMZN), PayPal (NASDAQ:PYPL), and all that. And then throughout those five years, we discovered even more opportunity within digital transformation, which is even more tech names that we ended up investing into.

I think this year has been a year of change in terms of how we perceive the world is going to progress in the next five years. And many of the technology names that we already outlined are going to face more headwinds from here, compared to the last five years. And a lot of digital transformation for them has been completed. And I've used Alphabet (NASDAQ:GOOGL) (Google) as an example, five years ago in terms of the advertising budget, one-third is being spent on digital media, which is Google, Facebook and then two-thirds of that would be on traditional media, which are TV and print.

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Five years later, that shift has turned upside down. Now it's two-thirds in digital media, and one-third in traditional media. So, unless you think traditional media is going to zero, which would not be the case because people still want to watch TV and read newspapers and go outside to events and all that, then it would be more difficult for digital media to capture the next 10% or 20% of the market share, compared to when they were only 30% of the market. And then they managed to double to 60% in the last five years. So, it’s more difficult for them now. So, a lot of this opportunity that we spoke of before, we are no longer interested [in], and some of them we have exited.

But there are some new areas that we think are going to benefit, such as re-shoring opportunities. And we started, maybe a bit too early, our investment into semiconductors last year and then we have been building our position this year as well, despite the headwinds. And if you think about what's happening [in] geopolitics, there's going to be a lot more silicon sovereignty in terms of coming back to the Western world, going back to the US, rather than being quite centred in Taiwan, which is Asia-Pacific, that's some sort of risk at the moment.

And then the other thing on the back of that is that we also started going into US railroads. Re-shoring is a fancy term, but no one is going to re-shore that base back into Europe, given the energy crisis, I think people are trying to shift away from Asia or shift away from China. But if you think about the US, the North American region, basically in Mexico, the West Coast and Canada, we do think there's going to be a lot more opportunity there, so the two railroads that we added this year, and we continue to build our position, would connect Canada to the West Coast and the West Coast to Mexico.

We also think that if you can find a high-quality energy company, then they could benefit at a sustained high level of oil price, which we think, based on the geopolitics, that the oil price could stay at a high level. We don't need to expect the oil price to go up to $100, $150. But if the oil price stabilises at about $70 to $80, I think certain companies are going to make a lot of profit, and at the same time return cash to shareholders. So, that is something that we are looking at now.

Kyle Caldwell: And could you name a couple of stock examples for those three sectors that you've been buying? So, US railroads, semiconductors, and energy.

Stephen Yiu: In terms of semiconductors in on our top 10, so it's ASML Holding NV ADR (NASDAQ:ASML) and Lam Research Corp (NASDAQ:LRCX). For the railroads they are not in our top 10 yet, but at some point, they could become top 10 positions, it's Union Pacific Corp (NYSE:UNP) and Canadian National Railway Co (NYSE:CNI). And in terms of an energy name now we're still building a position, so we haven't disclosed that yet.

Kyle Caldwell: And among your existing holdings, given the falls in stock markets in 2022, have you been using this as an opportunity to top up exposure, to take advantage of share price weakness?

Stephen Yiu: We have done a few things. I think we have positioned the portfolio in a very good shape now, looking at a different set of opportunities and selling some companies that we don't think are going to benefit in the next couple of years. And then increasing our position in certain companies that we think are going to do well. If you asked me to name a few names, we are still a big backer of NVIDIA Corp (NASDAQ:NVDA).

Nvidia shares have been quite volatile this year and it's down about 40% this year. But in terms of long-term prospects in artificial intelligence, in the growth in hyperscale data centres in terms of the increase in silicon content, in cars, in autos, in terms of all this infotainment, autonomous driving and all that, that has not changed, despite what happened this year. So, despite the fact Nvidia shares are down a lot, we reckon that Nvidia could be the next trillion-dollar company, which you don't have many [of] now.

The other thing we also invest in are medical technology companies, which is something we don't normally talk about because people just think that we are tech fund, but we are not a tech fund. We have recently added DexCom Inc (NASDAQ:DXCM) into our top 10, equally we also have Sartorius AG (XETRA:SRT) in our top 10. Dexcom [produces] a sensor you put on to your body to monitor your glucose intake and your level, and so for people with diabetes or with symptoms of diabetes, it's going to be quite helpful because you're going to have real-time data in terms of how much sugar content you have in your body. At the same time, Sartorius is a very high-quality business listed in Europe, and they basically sell equipment into biologics. So, if you think about how we managed to get our vaccine so quickly for Covid, it is because of biologics development. And we do recognise that biologics is going to be a bigger part of drugs development in the next few years and Sartorius will be the market leader in that area. So, we are very optimistic about those companies.

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Kyle Caldwell: The way you invest has drawn comparisons with Terry Smith. Would you say that's a fair comparison, and what would you highlight as the main differences?

Stephen Yiu: I would say that we share the same investment philosophy, which is to invest in high-quality businesses at an attractive price. We also run a high-conviction portfolio of between 25 to 35 stocks. I think what has been quite interesting in the last five years, or especially recently, is if you look at the implementation of this investment philosophy, [we] are very different.

So, if you look at our factsheet and our top 10, versus Terry's top 10, we probably overlap one to two holdings maximum. And if you go through the entire portfolio, we probably overlap maybe five to seven holdings out of 25. So, it's just the way that we interpret how we go about certain characteristics of a high-quality company such as competitive positioning, [and] recurring revenue stream. We ended up spotting a lot more opportunity in the software names, which I think Terry would have a bit less [of]. And the other thing that is a bit interesting is that over the last 12 months, I noted that funds may have been going into technology names while we have been reducing or exiting them. So, I think the time is still [too] early [to tell] who's right on that front in the next few years.

Kyle Caldwell: And finally, a question we ask all fund managers who we interview: do you personally invest in the Blue Whale Growth Fund?

Stephen Yiu: I invest only in one single fund, which is the Blue Whale Growth Fund. All my investible assets outside of property is in this fund. So, I don't invest in any other funds.

The other thing, which is maybe relevant to some in our audience, is that we recently, just because the valuation of our portfolio has become a lot more attractive and we think in the next few years the prospect for a high-level return would be more intact compared to, let's say, late last year, the company, Blue Whale Capital, started investing in the fund.

So, we started this journey, putting in about £120,000 into the Blue Whale Growth Fund. But the way that we've done it is we have employed a pound-cost-averaging exercise. So, every month we put in £10,000 at the beginning of the month and then, since August, when we started this exercise, we have now put in about £40,000 and then, of course, next week we will be putting in another £10,000.

And the reason we do that is because we think the valuation is very attractive now, but unfortunately, given the volatility in the market, it's impossible to say, ‘Oh, this is now the time, let's put everything in’, because you can easily see the market going down another 10% and you might end up regretting that decision. But I think through a journey of pound-cost-averaging strategy that we might be able to get a very good price in the next six to 12 months. So that is something that we believe in. So, Peter [Hargreaves] and I, we are basically doing this through the company.

Kyle Caldwell: Stephen, thank you for coming in. That's all we have time for today. You can check out the rest of our Insider Interviews on our YouTube channel, where you can like and subscribe. Hopefully see you next time’.